Why Contrarian Investors Should Consider Detroit

Although its economy is mired in a deep trough, Southeast Michigan is the “best buy-side story” in U.S. commercial real estate investing today, if you believe the market is poised for a rebound, says Steven Chaben, regional manager of the Detroit office of Marcus & Millichap. Agraduate of Wayne State University and the Detroit College of Law who has spent his entire 25-year business career in the local market, Chaben knows a good deal when he sees one.

“We tell buyers that pricing has adjusted [downward] a lot, and that you are probably making better buys today than at anytime in the last 20 years,” says Chaben. How attractive are initial yields? Well, Marcus & Millichap reports that metro Detroit office properties traded at an average capitalization rate of 10.7% during the first three quarters of 2008, up from 8.3% during the same period in 2007.

The average cap rate locally on apartment sales has climbed 80 basis points over the past year to reach 8.4%. That's despite a drop of 40 basis points in the vacancy rate over the past year to 6.2%. By comparison, the average vacancy rate nationally is 6.1%, according to research firm Reis. Local apartment owners have benefited by limited new supply and a spate of home foreclosures as displaced homeowners turn to the rental market.

While Detroit's apartment vacancy rate is expected to rise 30 basis points by year's end amid a weakening job market and net out-migration trends, the local apartment fundamentals are solid by any measure. Even so, many lenders give the market a cold shoulder, says Chaben. “A lender will get a better debt-coverage ratio here than he'll get anywhere, and yet he's shying away from here like he's got the plague.”

The latest economic forecast from The University of Michigan offers lenders little comfort. Over the next two years, Michigan is expected to shed 132,000 jobs, most of them in manufacturing, pushing the unemployment rate above 10%. Of the 77,000 projected job cuts in manufacturing over the next two years, most will be in the auto industry. The report projects that the state economy will experience modest job gains in 2011.

Uncertainty over the result of last month's request by the Big Three automakers for a $25 billion bridge loan from the federal government has led many office tenants — even non-automotive ones — to delay decisions regarding their space needs, says Todd Pardon, senior vice president of Southfield, Mich.-based Redico, a prominent office owner and diversified developer. “Up to that point, we were just humming along. We've completed 4.2 million sq. ft. of leasing transactions in this market this year.”

In November, the CEOs of General Motors, Ford and Chrysler testified on Capitol Hill. After two intense days, lawmakers instructed the auto execs to come back in December with a business plan detailing how the money would be spent.

Chaben can't help but notice how much tougher lawmakers are on the auto executives than they have been on banking institutions seeking financial assistance to stay afloat. In November, the U.S. Treasury agreed to make a $20 billion investment in Citigroup. That hefty sum follows the $25 billion the federal government injected into the bank as part of the $700 billion bailout package passed by Congress in October.

There were no hearings to consider Citigroup's plight, or cries for the bank to offer a business plan, says Chaben. “I would suggest to you that is a great example of the double standard that runs so rampant.” The anti-Detroit bias has Chaben muttering to himself that famous line from the movie “Network”: “I'm as mad as hell and I'm not going to take this anymore.”

The question is how can Detroit diversify its economy? There is no silver bullet, but Oakland County, home to Chrysler's world headquarters, may have one answer. The county's Emerging Sectors program has identified the top 10 growth sectors — ranging from alternative energy and power generation to robotics to medical devices — and targeted the top companies in those sectors to expand their business in the county. Over four years, the program has led to $1 billion in new investment.

“The survival of the area depends on the transfer of technology,” says Pardon of Redico. “Michigan has a lot of technological capability stemming from its automotive uses, and I think over time we'll be accessing those resources.”

That brings us back to Chaben, the broker who believes the wheels are being set in motion for future business growth and prosperity in Southeast Michigan. His advice to propertybuyers: “Get in now while you can still get deals at a 10 cap.”